Hot Topics in the Supply Chain: The Problem of Cheap

There is a problem that every supply chain manager should be aware of: it is called Gresham’s law. The law is described in many economic textbooks, and some readers might remember learning about it in a college economics class. In its original context, Gresham’s law discussed the implications of when good and bad money are circulating in the economy. Good money, such as gold-based coins, hold their value, while bad money, such as paper bills, do not. Eventually, the good coins are moved out of circulation because they are considered valuable and hence collected by hobbyists and others who appreciate the worth of the coin. What remains in circulation are low-value coins and paper money.

GRESHAM’S LAW AND DISCOUNT GOODS

Writer Ellen Shell (2009) extended the application of Gresham’s law to consumer goods. She maintains that in a discount-oriented consumer market, products will eventually sink down in quality to the lowest common denominator because shoppers are simply looking for the best price, even if the quality of the product is marginal. What results is an array of products that are low in quality and cheap in price. “It’s simple economics that companies will sell the worst products that people are willing to pay for” (Segan 2008, p. 68). This can become frustrating for shoppers who really desire to spend a little more and buy a better-quality product. Gresham’s law, according to Shell, dictates that only mediocre products will be left in the marketplace.

Of course, not all product lines follow this progression toward cheap quality. The ones most susceptible seem to be those sold in big box stores, dollar stores, and discount retail stores (Shell 2009). However, there can be collateral damage to those companies that truly want to sell a good product; they must be aware of the distribution and retail channels that are out there. For example, a high-quality product that is marketed through the discount channels will eventually sink down to the lowest common denominator in that market. This means what was once a good product will need to be cheapened so it can sell in the market. Cheapening the product means lowering its manufacturing cost, so it can be sold to a retailer, who will sell it to the discount conscious shoppers. Eventually, only the cheapest products will sell and those of higher quality will no longer appeal to the consumer. Hence, by Gresham’s law, bad products drive out good products.

WHERE HAVE ALL THE GOOD PRODUCTS GONE?

The quest for cheap products explains why some manufacturers move their supply chains to Asia or cut benefits to their employees working on the domestic front. Discount retailers that sell these products must keep their overhead and expenses low as well; hence, employees are paid less and if benefits are offered, many of the employees cannot afford them anyway.

So where have all the good products gone? The answer of course is that good products abound everywhere, but not necessarily in the discount retail industry. This industry is dominated by Wal-Mart, dollar stores, big box stores, and the like. Because consumers tend to be more price centric, products that sell well in the discount industry may not be the best in quality (Fishman 2005; Shell 2009). This is all fine as long as consumers are aware of the limitations of shopping in this sector. Indeed, there is a sense where consumers must realize that if they pay little now, they will pay more later. Sascha Segan comments in PC Magazine that paying a low price on a laptop up front may mean paying a price later in a loss of customer service, durability, and reliability (Segan 2008).

LINK TO INNOVATION

Even if a company does not operate in the discount retail industry, it still behooves all managers to take note of Gresham’s law. The problem is there is always a tremendous force to cut costs in any industry, discount, or otherwise. When the focus becomes on cutting costs, then a loss of innovation may result. Innovation is the force that creates new ideas and products. But when management is preoccupied with cost cutting, innovation, in the form of R&D expenditures, often decreases. If new products and new ideas are not forthcoming from a company, then it is reduced to offering whatever it offers at the cheapest price possible. It focuses on the short-term results of keeping income and stock prices up, while failing to position itself for long-term growth in the future.

For companies that solely operate in the discount industry, writer Ellen Shell (2009, p. 209) offers a bleak legacy of what could happen:

“When competition is mostly about price, innovation too often takes a backseat to cost cutting. Laying off workers and hiring cheaper ones is one sure way to enhance the bottom line. Another is to scour the world for low-wage workers, especially those in countries with lack-luster enforcement of environmental and workers’ rights regulations. Neither of these tactics is innovative, and neither is in the long-run contributes to growth.”

A preoccupation of scouring the world for low-wage workers in countries with lax environmental and workers’ rights does not sound like a legacy to be proud of. Hence, this dilemma remains a hot spot in the supply chain.

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Strategic Orientation

Usually, a business tries to satisfy either the price or the service orientation. Price represents an orientation toward the minimal allocation of resources to the transformation process, while a service orientation requires a more generous allocation of resources to the transformation process.

An orientation toward price appeals to customers with limited income, while customers with a more comfortable income level generally look for more service. Designing the customer interface considers these differences. A price orientation involves little direct customer contact, perhaps only a hello from a salesperson, who is busy stocking or rearranging merchandise as the customer enters the door. A service orientation may involve a warmer and more committed offer of assistance by a salesperson that drops whatever task they were doing to be completely available to the incoming customer for as long as the customer is in the store. A particularly effective action may involve greeting the customer by name. Some women clothing stores offer a service whereby a salesperson will select a number of combination outfits, including accessories, for a prospective customer to consider so that the customer does not have to wander through the store to mix and match separate items. Often, this selection process is done before the customer arrives to avoid waiting. Salespersons can cultivate a following of loyal customers who seek out that salesperson when they come to the store.

In a price-oriented business, the product assortment will focus on fast-moving items. This strategy reduces the commitment of resources to slow-moving or excess inventory items and reduces the need for markdowns. In a service-oriented business, the product assortment will be broader or deeper or both.

Product quality will be high in a service-oriented business, while it will be lower in a price-oriented business. Lower prices can be achieved through fewer features in the product, less costly materials, or lower quality acceptance standards.

Price-oriented businesses aim for higher inventory turns. This strategy means the store will have a more limited selection of goods and will probably experience a higher stockout rate than for service-oriented businesses that carry a more liberal assortment of goods in their inventories.

In service-oriented businesses, employees will be more knowledgeable, because of better training and a company culture that emphasizes excellent service, than in price-oriented businesses. They will possess more product knowledge and will interact with the customer more effectively than those employees in a price-oriented business. This is not to imply that price-oriented businesses are inferior in some way, but the trade-off for lower product prices is less customer service, which is a simple economic reality.

The retail facility in a price-oriented business will contain only the necessities. Customers will tend to select their items and buy quickly. On the other hand, the service-oriented business requires a facility with many customer-oriented extras, such as attractive décor, inviting product displays, and convenient checkout counters. Customers will not rush to buy or leave. Indeed, the experience of shopping is part of the goal of the customer-oriented business. Price-oriented businesses will tend to have large stores, often freestanding, in lower-cost areas where customers can get in and out quickly. Service-oriented businesses will tend to have smaller, or departmentalized, stores in malls, where customers can enjoy a shopping experience.

Information systems are critical in the design of retail stores. In a price-oriented business, he emphasis will be on keeping the costs low, while service-oriented businesses will build more customer-friendly features into the system, such as remembering customer birthdays, providing alerts for upcoming specials, catering to shopping preferences, and encouraging frequency of visits.

― Richard E. Crandall, William R. Crandall, Charlie C. Chen, Principles of Supply Chain Management, Second Edition.